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Transfer Pricing Definition & Transfer Pricing Methods

Meaning of Transfer pricing :

When one branch or related party of a multinational company in one country transfers goods, services or know-how to another part / branch in another country, the price charged for these goods or services is called ‘transfer price’. And transfer pricing is a method to compute this price. Generally the transaction between these related parties should happen at an arm length price.

Example :

If ABC ltd is Singapore based company having branches in almost all countries in Asia . In India its operations are being carried on by BAC Ltd. a 100% subsidiary of ABC Ltd. When any transaction takes place between the two entities which results an impact on the amount of tax to be paid then in such cases transfer pricing arises.

Arm length price :

The “arm’s length price” of transfer pricing means the amount charged by one related party to another for a given product / service must be the same as if the parties were not related. An arm’s length price for a transaction is therefore what the price of that transaction would be in the open market.

2. Cost plus method :

A. This method determines arm length price by adding Gross Profit Margin earned in comparable transaction / by comparable companies to the cost incurred by Tested Party under controlled transaction.

B. This method is useful when tested party is supplying made to order goods for example electronic gadgets that can be finished simply by assembling ,to its related party .

C. This method can also be considered for provision of services.

D. It determines arm’s length sale price for goods or services

Therefore, it would be applicable primarily in case of transfer of goods / services between Tax Holiday and other units
In other cases, it can be applied only where the other party is treated as ‘Tested Party’.

5.Profit split method :

B. This method is used when related enterprise transactions are included that it becomes very hard to conduct a transfer pricing analysis on a transactional base. The priority function to do is combined net profit acquiring to connected entities from a transaction is decide. After that combined net profit is allotted in between connected entities with mention to market income gained by free enterprises in comparable transactions.